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What Is An Owner-Occupied Commercial Development?

Property News

Many businesses cannot find premises that meet their long-term requirements. The location, size or spec of properties available are just not what they need. If a suitable site can be found then some businesses look to acquire and develop themselves.

The advantage of this strategy is that the business gets the building that it needs.  In addition, by owning the freehold the business has control over future building alterations. It is also free from rental obligations and benefits from any rise in capital value.

The downsides are that the time and resource needed to complete a successful development can be time consuming.  Cash will potentially be tied up in the building for many years.  The business will incur any fall in capital value and may not be able to sell the building easily.

If the upsides outweigh the downsides then keep reading to find out how to finance the development. 

Is there a difference to standard development finance?

A lender will undertake a detailed review of the project.  They will appoint a quantity surveyor to verify costs and a valuer to review the purchase price and final completed price. In addition, the lender will want to know that the development is being undertaken by an experienced contractor.  All of these factors bare the same as a standard project for a professional developer.   

The key difference is how the lender assesses the exit i.e. the repayment of the loan.  A professional developer would normally sell the site to repay the loan or let out the site and take a commercial mortgage.  In this scenario the business will retain the property.

Therefore, the key assessment that a lender will make is, does the business make sufficient trading profit to allow it to raise a commercial mortgage to repay the development loan.  This affordability test is critical to whether development finance can be raised.   

Loan size and affordability test

A lender will restrict the development finance loan to an amount they believe is an achievable mortgage on completion of the project.  Getting an early review of the mortgage possibility is therefore key.

The affordability is calculated from free cash flow of the business.  Lenders will use the profits of the company (looking back at least 2 years) adjusted for non-cash items such as depreciation but deducting items such as dividends and known capital expenditure.  An estimate of the mortgage commitments is calculated being the total interest and capital repayments.   Mortgage lenders tend to look for a cover of x1.75- x2.25.  This means that the free cash flows have to exceed the loan repayments by this ratio. 

If the profits are sufficient, then mortgages of up to 75% of the value of the finished property should be available.  It is often the case that the affordability test reduces the loan available.

A development loan is typically capped at 60-65% of the expected Gross Development Value (GDV) or 75%-80% of the total costs of the development or the value of the end mortgage available whichever is lower or.

Lenders available

The number of lenders available to support a commercial development is much lower than for residential developments.  This is because of the specialist nature of the build, but also more importantly the restrictive sales market.  Commercial properties are generally harder and slower to sell than residential.

This means it is important to seek advice early on to the identify potential lenders.

It is possible to find lenders that support the development and the end mortgage.  This is an ideal situation as it lowers the risk to the business of not being able to find a mortgage when the project is complete.  A lender that offers the final commercial mortgage will perform their own serviceability test and when offering terms on the development know that they will switch to a mortgage at the end.

High street banks can offer this type of loan structure and will often be the most competitive on rates.  Do expect the level of review and the hurdles to be high when approaching a high street bank and they tend to like very well-established businesses only.   

If you are considering embarking on an owner-occupied development project, speak to us early to get a full review of your circumstances and to ensure an efficient application process.

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